USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
The Fed turned a lot more hawkish than expected in Dec. They doubled the pace of tapering to $30 billion per month which will see QE concluded by March 2022 as was widely expected. Surprisingly though the Summary of Econ Projections showed the median dot plot pencilled in 3 hikes for 2022 (up from the previous 1), confirming Fed Fund Future expectations. Fed Chair Powell explained they hadn’t decided whether to pause between the end of tapering and a first hike but reiterated that rates will likely only rise when QE has concluded. Another positive shift was Powell’s comments that they could raise rates before full employment has been met due to high inflation , and stated that with inflation above target, they cannot wait too long to get to maximum employment as current inflation levels is seen as a threat to max employment. The hawkish tilt went further to note that the bank started discussing the balance sheet but said no decisions were made on when QT might commence. Even though the dots projected 3 hikes for 2022, the updated rate trajectory only showed 1 additional hike over the forecast horizon, which combined with a lower terminal rate was less hawkish than some had feared. Nonetheless, the meeting marked a material hawkish shift from the Fed, putting it on par with the likes of the RBNZ. The meeting minutes also revealed that the QT discussion saw majority of members thinking it appropriate to start QT soon after rate lift off and another more hawkish tilt than expected from the Fed.
2. Global Risk Outlook
The growth & inflation outlook will be key for the USD, not only growth and inflation in the US but also global. The USD is often inversely correlated to global growth & inflation , doing bad during reflationary environments (growth and inflation accelerating), while the USD usually does well in disinflationary environments (growth and inflation decelerating). Thus, with expectations that both growth and inflation will decelerate this year, both in the US and the globe, that should be a positive input for the USD in the med-term . However, it also means there will be a lot of focus on the incoming data to see how it develops and how the Fed responds to it. For example, if the economic outlook worsens materially, the Fed could backtrack on their current aggressive path, which could mean downside for the USD if money markets start pricing out hikes, so incoming data is key.
3. CFTC Analysis
Latest CFTC data showed a positioning change of -1186 with a net non-commercial position of +37892. The shortterm unwinding of stretched USD longs played out exactly as expected. Even though the CFTC data does not show a big unwind we need to remember the big downside move in the USD started on Wednesday, which means last week’s COT data will not include any of that, so take this week’s data with a pinch of salt. With the fundamental bias unchanged, the real question is whether the flush we saw this past week is over.
4. The Week Ahead
In the week ahead, things will be very quiet on the data front for the US, with US participants also away on Monday for a bank holiday. Thus, a lot of the Dollar’s flow will be dictated by overall risk sentiment, key events for other major currencies, and of course focus on whether the bond and equity market continue to provide mixed signals on the growth and inflation outlook in the midst of the Fed’s current aggressive policy path. With markets pricing in well over 3 hikes for the Fed this year already, there is arguably still a lot of disappointment for money markets on this front if the economic picture starts to rapidly deteriorate. Even though that could add pressure to the USD as positioning gets squared up, keep in mind that a disinflationary environment is also usually USD positive, which means the path in the very short-term for the USD is less clear than we would have hoped it to be. In the week ahead the key technical levels to watch is key support between 94.70 and 94.50. We spoke about the importance of these levels a couple of times this past week and saw a solid bounce from that zone on Friday. A continuation of that bounce arguably opens up a retest of previous key support around 95.60, however if we push lower and take out key support it opens up for a move towards 93. 40 , so we are at a very important juncture right now from a technical and momentum perspective.
CAD
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
In Dec the BoC left rates at 0.25% as expected and maintained forward guidance where it expects rates at current levels until the middle quarters of 2022. This disappointed some participants who were looking for the bank to announce that the output gap could be closed in 1Q22. On inflation, even though the bank still thinks it will ease from 2H22, they did drop ‘temporary’ when referring to price pressures, similar to the Fed’s removing the word ‘transitory’. The bank took a slightly bleaker view on growth, pointing to both the new Omicron variant and flooding in British Columbia as possibly drags on growth and something that could elevate supply chain issues. What disappointed markets a bit was that the bank said none of the recent developments warrants any further adjustments to normalization, which disappointed the bulls looking for a possible hawkish tilt. The bank noted that employment is back to pre-covid levels, and economic momentum in Q4 were solid, but the overall tone wasn’t enough to convince markets of a Jan hike at that time, but markets have since then continued to ramp up hike bets with money markets pricing in a >70% chance of a hike at the Jan meeting and pricing in close to 6 hikes for 2022. Keep in mind that the bank was already concerned about growth before the recent Omicron restrictions, which means the likelihood of them brining forward output gap projections seems unlikely and for that reason we think is setting up for a disappointment and possible repricing lower in money market expectations in the upcoming meetings.
2. Intermarket Analysis Considerations
Oil’s massive post-covid recovery has been impressive, driven by three drivers: supply & demand (OPEC’s production cuts); improving global economic outlook and improving oil demand outlook, even though slightly pushed back by Delta concerns; higher for longer than expected inflation. Even though Oil has recovered a lot of its recent downside and have proven our caution wrong, we are still cautious going into the first two quarters. The drivers keeping us cautious is expectations of a more hawkish Fed, slowing growth and inflation, lower inflation expectations (due to the Fed) and a possible supply surplus in 1Q22. If our concerns
do materialize into downside for oil prices it should put pressure on the CAD. There have however been shortterm drivers supporting Oil prices and has kept the CAD more supported than we would have expected.
3. Global Risk Outlook
As a high-beta currency, the CAD usually benefits from overall positive risk sentiment as well as environments that benefit pro-cyclical assets. Thus, both short-term (immediate) and med-term (underlying) risk sentiment will always be a key consideration for the CAD.
4. CFTC Analysis
Latest CFTC data showed a positioning change of +3649 with a net non-commercial position of -7376. Recent price action has seen the CAD take a very similar path compared to April and Oct 2021 where markets were way too aggressive to price in upside for the CAD only to see majority of it unwind. We think the CAD is setting up for a similar disappointment with money markets way too aggressive on rate expectations for 2022.
5. The Week Ahead
In the week ahead the main event we’ll be watching for the CAD is Wednesday’s CPI data. The aggressive pivot from the Fed has seen markets pricing in a potential similar pivot for the BoC, but that seems unlikely for a few reasons. Firstly, as noted above the output gap projections are unlike to have changed between now and December, with the higher probability that the bank sounds even more cautious on growth with the recent Omicron restrictions only coming online after their Dec meeting (if growth already was a concern before that, it seems strange that they would suddenly see a brighter outlook after more restrictions were implemented). Secondly, and in connection with this week’s CPI, Canada does not have the same price pressure compared to the US (with US Core CPI sitting at 5.4% and the average of the BoC’s preferred measure of Core CPI sitting at 2.74%. That means CPI will be important this week, because if we see yet another uninspiring print this week, that should see some of the aggressive policy bets unwind and would be a negative input for the CAD. At the same time, even if we see a beat, with almost 6 hikes already priced, what more can the market price in?
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
The Fed turned a lot more hawkish than expected in Dec. They doubled the pace of tapering to $30 billion per month which will see QE concluded by March 2022 as was widely expected. Surprisingly though the Summary of Econ Projections showed the median dot plot pencilled in 3 hikes for 2022 (up from the previous 1), confirming Fed Fund Future expectations. Fed Chair Powell explained they hadn’t decided whether to pause between the end of tapering and a first hike but reiterated that rates will likely only rise when QE has concluded. Another positive shift was Powell’s comments that they could raise rates before full employment has been met due to high inflation , and stated that with inflation above target, they cannot wait too long to get to maximum employment as current inflation levels is seen as a threat to max employment. The hawkish tilt went further to note that the bank started discussing the balance sheet but said no decisions were made on when QT might commence. Even though the dots projected 3 hikes for 2022, the updated rate trajectory only showed 1 additional hike over the forecast horizon, which combined with a lower terminal rate was less hawkish than some had feared. Nonetheless, the meeting marked a material hawkish shift from the Fed, putting it on par with the likes of the RBNZ. The meeting minutes also revealed that the QT discussion saw majority of members thinking it appropriate to start QT soon after rate lift off and another more hawkish tilt than expected from the Fed.
2. Global Risk Outlook
The growth & inflation outlook will be key for the USD, not only growth and inflation in the US but also global. The USD is often inversely correlated to global growth & inflation , doing bad during reflationary environments (growth and inflation accelerating), while the USD usually does well in disinflationary environments (growth and inflation decelerating). Thus, with expectations that both growth and inflation will decelerate this year, both in the US and the globe, that should be a positive input for the USD in the med-term . However, it also means there will be a lot of focus on the incoming data to see how it develops and how the Fed responds to it. For example, if the economic outlook worsens materially, the Fed could backtrack on their current aggressive path, which could mean downside for the USD if money markets start pricing out hikes, so incoming data is key.
3. CFTC Analysis
Latest CFTC data showed a positioning change of -1186 with a net non-commercial position of +37892. The shortterm unwinding of stretched USD longs played out exactly as expected. Even though the CFTC data does not show a big unwind we need to remember the big downside move in the USD started on Wednesday, which means last week’s COT data will not include any of that, so take this week’s data with a pinch of salt. With the fundamental bias unchanged, the real question is whether the flush we saw this past week is over.
4. The Week Ahead
In the week ahead, things will be very quiet on the data front for the US, with US participants also away on Monday for a bank holiday. Thus, a lot of the Dollar’s flow will be dictated by overall risk sentiment, key events for other major currencies, and of course focus on whether the bond and equity market continue to provide mixed signals on the growth and inflation outlook in the midst of the Fed’s current aggressive policy path. With markets pricing in well over 3 hikes for the Fed this year already, there is arguably still a lot of disappointment for money markets on this front if the economic picture starts to rapidly deteriorate. Even though that could add pressure to the USD as positioning gets squared up, keep in mind that a disinflationary environment is also usually USD positive, which means the path in the very short-term for the USD is less clear than we would have hoped it to be. In the week ahead the key technical levels to watch is key support between 94.70 and 94.50. We spoke about the importance of these levels a couple of times this past week and saw a solid bounce from that zone on Friday. A continuation of that bounce arguably opens up a retest of previous key support around 95.60, however if we push lower and take out key support it opens up for a move towards 93. 40 , so we are at a very important juncture right now from a technical and momentum perspective.
CAD
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
In Dec the BoC left rates at 0.25% as expected and maintained forward guidance where it expects rates at current levels until the middle quarters of 2022. This disappointed some participants who were looking for the bank to announce that the output gap could be closed in 1Q22. On inflation, even though the bank still thinks it will ease from 2H22, they did drop ‘temporary’ when referring to price pressures, similar to the Fed’s removing the word ‘transitory’. The bank took a slightly bleaker view on growth, pointing to both the new Omicron variant and flooding in British Columbia as possibly drags on growth and something that could elevate supply chain issues. What disappointed markets a bit was that the bank said none of the recent developments warrants any further adjustments to normalization, which disappointed the bulls looking for a possible hawkish tilt. The bank noted that employment is back to pre-covid levels, and economic momentum in Q4 were solid, but the overall tone wasn’t enough to convince markets of a Jan hike at that time, but markets have since then continued to ramp up hike bets with money markets pricing in a >70% chance of a hike at the Jan meeting and pricing in close to 6 hikes for 2022. Keep in mind that the bank was already concerned about growth before the recent Omicron restrictions, which means the likelihood of them brining forward output gap projections seems unlikely and for that reason we think is setting up for a disappointment and possible repricing lower in money market expectations in the upcoming meetings.
2. Intermarket Analysis Considerations
Oil’s massive post-covid recovery has been impressive, driven by three drivers: supply & demand (OPEC’s production cuts); improving global economic outlook and improving oil demand outlook, even though slightly pushed back by Delta concerns; higher for longer than expected inflation. Even though Oil has recovered a lot of its recent downside and have proven our caution wrong, we are still cautious going into the first two quarters. The drivers keeping us cautious is expectations of a more hawkish Fed, slowing growth and inflation, lower inflation expectations (due to the Fed) and a possible supply surplus in 1Q22. If our concerns
do materialize into downside for oil prices it should put pressure on the CAD. There have however been shortterm drivers supporting Oil prices and has kept the CAD more supported than we would have expected.
3. Global Risk Outlook
As a high-beta currency, the CAD usually benefits from overall positive risk sentiment as well as environments that benefit pro-cyclical assets. Thus, both short-term (immediate) and med-term (underlying) risk sentiment will always be a key consideration for the CAD.
4. CFTC Analysis
Latest CFTC data showed a positioning change of +3649 with a net non-commercial position of -7376. Recent price action has seen the CAD take a very similar path compared to April and Oct 2021 where markets were way too aggressive to price in upside for the CAD only to see majority of it unwind. We think the CAD is setting up for a similar disappointment with money markets way too aggressive on rate expectations for 2022.
5. The Week Ahead
In the week ahead the main event we’ll be watching for the CAD is Wednesday’s CPI data. The aggressive pivot from the Fed has seen markets pricing in a potential similar pivot for the BoC, but that seems unlikely for a few reasons. Firstly, as noted above the output gap projections are unlike to have changed between now and December, with the higher probability that the bank sounds even more cautious on growth with the recent Omicron restrictions only coming online after their Dec meeting (if growth already was a concern before that, it seems strange that they would suddenly see a brighter outlook after more restrictions were implemented). Secondly, and in connection with this week’s CPI, Canada does not have the same price pressure compared to the US (with US Core CPI sitting at 5.4% and the average of the BoC’s preferred measure of Core CPI sitting at 2.74%. That means CPI will be important this week, because if we see yet another uninspiring print this week, that should see some of the aggressive policy bets unwind and would be a negative input for the CAD. At the same time, even if we see a beat, with almost 6 hikes already priced, what more can the market price in?